
		Ronald J. Cappuccio, J.D., LL.M.(Tax) *Counsellor at Law*	1800 Chapel Avenue West Suite 128 Cherry Hill, New Jersey 08002 USA (856) 665-2121 Fax (856) 665-9005 E-mail: Ron@TaxEsq.com

Taxation of Limited Liability Companies

Single Member Limited Liability Companies are generally ignored for tax purposes and are therefore taxed as a sole proprietorship (1040 Schedule C). Multi-member Limited Liability Companies are generally taxed as a Partnership (Form 1065).

A. Entity Classification Selection.

As of January 1, 1997, Treas. Regs., Section 301.7701-1-3 superceded the former complication process for determining the tax treatment of an LLC. The Internal Revenue Service created the Entity Classification Election (Form 8832). This form known as the "check the box" form is used to determine the tax status for the organization. Limited Liability Companies, because they are not incorporated entities, are eligible for filing Form 8832, as are Partnerships and Limited Partnerships. Single Member LLCs may also file Form 8832. Even though multi-member LLCs are automatically treated as a partnership, and sole member LLCs are treated as sole proprietors, submit the form in any case. This assures the affirmative selection of the type of taxation for the entity and that there is no confusion.

B. LLC Treated as a Partnership.

Multi-member LLCs are classified as a Partnerships for Federal Tax purposes. Generally, Partnership tax treatment as a "pass-through" entity is more favorable than "C" Corporations. Partnerships are subject only to a single Federal Income Tax at the partner level. "C" Corporations are subject to tax at the corporate level and at the shareholder level and therefore can be subject to "double taxation." Even though an "S" Corporation is also a pass-through taxation entity, it is subject to stricter eligibility standards and limitations on its classes of stock. This restriction on the equity/capital structure of "S" Corporations limits the flexibility in planning especially for inter-generational business transfers. These restrictions include a limitation that an "S" Corporation can have no more than 75 shareholders, and shareholders can only be individuals and estates (some trusts). Further, the "S" Corporation can only have one class of stock compared to a Limited Liability Company issuing a variety of different ownership interest.

C. LLC Taxation Compared to "S" Corporations for Entity Level Debt.

Members of LLCs taxed as Partnerships obtain basis in their LLC interest not only from the contributions/payments for their membership interest, and also including allocated share of LLC debts pursuant to IRC Section 752. In contrast, IRC Section 1366 provides that "S" Corporation shareholders obtain basis for their contributions for their stock plus the amount of loans that they make to the corporation. Even if a shareholder personally guarantees a corporate debt, that will not increase his/her basis. When a Limited Liability Company membership interest is purchased, the purchaser can step up the tax basis of his/her unappreciated LLC assets to reflect the purchase price pursuant to IRC Section 754. There is no similar adjustment provision available for purchasers of "S" or "C" corporate stock.

D. Distribution of Property.

LLC members can make tax-free contributions of appreciated property to the LLC pursuant to IRC Section 721. Tax-free distributions of appreciated property. To the members are also permitted pursuant to IRC Section 731. Non-recognition treatment is available for appreciated property contributed to an "S" Corporation only when the transferor is in control of the corporation immediately after the transaction. Pursuant to IRC Section 351, the most significant difference is that when appreciated corporate property is distributed to "S" or "C" Corporation shareholders, the gain is recognized at the corporate level as if the property were sold at fair market value (see IRS Section 311(b).

E. Flexibility of Special Allocations.

Corporations must allocate dividends in accordance with stock ownership. Because an LLC is treated as a partnership, special tax allocations, income, gain, loss, deductions, or credits may be made among the LLC members pursuant to IRC Section 704. For example, one member may receive 70% of the operating profit, yet only 50% of the gain on the sale of the business by the LLC.

F. LLC's have Partnership Termination Rules

. Change in ownership of the corporate shares does not terminate a "C" or "S" Corporation for Federal Tax purposes. Because a multi-member LLC is considered a Partnership, it is subject to the Termination Rule of IRC Section 708(b). An LLC terminates for Federal Income Tax law purposes whenever 50% or more of the interest in capital and profits are sold within a 12 month period. This means that even though the LLC may technically still be in existence under State Law, for tax purposes, it terminates and re-starts. This has the same effect establishing a new entity for accounting purposes, and brings the current LLC tax year to a close.

G. Non-Recourse Debt Allocation.

Unless an individual member is personally liable for an LLC debt if the debt is secured by contributed property, LLC debts are non-recourse with respect to members. The LLC debts are therefore allocated under IRC Section 752 among the members in accordance with their membership interest.

More Information On LLC's

Limited Liability Company Taxation

Single Member LLCs

Comparison of LLC's to Corporations

Businesses Suitable for LLC's

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